Financial guarantees

Lecture content:

1. The central role of the consumer in the natural gas market
2. Natural gas supply contracts
3. Other contracts and financial guarantees in the natural gas market
4. The problem of imbalances and the role of financial guarantees
5. Conclusions
6. Active links (NPAs, standards, resources)
7. Glossary
8. Questions for self-testing

 

1. The central role of the consumer in the natural gas market

The central figure of the natural gas market is the consumer, because it is he who pays for all services and costs related to the energy resource:

• cost of natural gas,
• distribution services (through the supplier),
• transportation services,
• storage and other costs borne by suppliers.

All other market entities — suppliers, GTS operators, GDM operators, traders, gas storage facilities — belong to business entities. Their main goal is to make a profit. They can be conditionally called “fighters for the consumer’s monetary resources,” because it is the financial stability of the entire system that depends on the solvency of the end customer.

The natural gas market operates solely on the basis of contractual relations:

• A natural gas supply contract is concluded by each consumer with the selected supplier;
• If the consumer is connected to the gas distribution system, he must also conclude a natural gas distribution contract.

An important detail: the current legislation provides that only the consumer has the right to conclude a natural gas distribution contract. This guarantees his right to independently determine the volume and nature of the use of services, as well as to directly regulate relations with the gas distribution system operator.

 

2. Natural gas supply contracts

2.1. Consumer segmentation and financial guarantees

Consumer categories

• Household consumers – households that use gas for cooking, water heating and/or heating.
• Non-household consumers – enterprises, organizations and other business entities.

Contractual relations of non-household consumers

• Are based on the principles of contract law.
• The terms of financial guarantees are determined by the free will of the parties – the supplier and the consumer.
• The most desirable model for the supplier is prepayment, when the consumer pays 100% of the cost of the planned volume of gas before the beginning of the billing month.

Practice settlements

• Actual consumption never coincides with the forecast.
• At the end of the month, two options are possible:

• the consumer pays extra for the excess volume,
• the supplier either returns the funds or credits them to the next period.

• Current trends:

• prepayment is applied partially or not set at all;
• common models of decadal or average monthly payment;
• for large non-household consumers, payment deferrals are possible.

Advantages of non-household consumers

• Possibility agree terms with the supplier, dictating more favorable options.
• Suppliers are interested in selling gas, so they are ready to make concessions.

Protection of the supplier’s rights

• In the event of arrears, there is a direct rule of law that the supplier has the right to initiate termination of gas supply through:

• the information platform of the GTS Operator,
• or through the GRM Operator, which carries out the actual disconnection.

Financial guarantees in the natural gas market are a key tool for minimizing supplier risks. Non-household consumers have more room for maneuver in choosing terms, while household consumers work under a standard contract with strictly defined rules.

 

2.2. Gas supply interruption and restoration mechanisms

General principle:
A consumer, both non-domestic and domestic, always has priority in relations with the supplier, except in cases of non-payment for services.

Legal grounds:

• In the presence of debt, the supplier has the right to initiate the termination of gas supply:

• through the information platform of the GTS operator;
• or directly to the GDM operator with an order to disconnect the consumer.

Seasonal consumers:

• Often they are the ones who accumulatedebts in the off-season.
• When the period of economic activity begins, in order to resume supply, they must:

1. conclude a debt restructuring agreement;
2. or provide financial security provided for by the Civil Code (surety, pledge, etc.).

Guarantee agreement:

• a third party acts as a guarantor;
• the guarantor pays the debt instead of the consumer;
• the supplier, after receiving the funds, restores gas supply;
• the guarantor then independently regulates financial relations with the consumer.

Restructuring and surety mechanisms ensure a balance of interests:

• the consumer receives restoration of gas supply,
• supplier – a guarantee of receiving funds,
• market – stability and fulfillment of contractual obligations.

 

2.3. Household consumers and financial guarantees

Specifics of settlements

• Household consumers pay for natural gas upon consumption at the end of the month.
• They work under a standard contract approved by the National Commission for the Regulation of Energy and Utilities of Ukraine, which:

• makes it impossible for the supplier or consumer to change its terms;
• at the same time guarantees uniform rules for all household customers.

• The consumer has the right voluntarily to pay a part of the funds for future consumption in advance, but this is not mandatory.

Consequences of non-payment

• If a household consumer accumulates debt, the supplier has the legal right to terminate gas supply.

Categories of household consumers

1. Comprehensive use of gas (mainly private homes):

• heating;
• water heating;
• cooking.

2. Partial use of gas (usually apartments in high-rise buildings):

• only cooking;
• only water heating;
• both of these services together.

Problems of disconnections

• In multi-apartment buildings, it is difficult to physically disconnect the debtor from the system, since access to the apartment limited.
• In private homes, gas distribution system operators often use a simpler and faster method – mechanical disconnection from the gas distribution system, which forces the debtor to pay.
• Sometimes, such practices of gas distribution system operators cause criticism, as they border on abuse of rights.

 

3. Other contracts and financial guarantees in the natural gas market

3.1. Natural gas distribution contract

• Concluded by any consumer with the gas distribution system operator (GDM).
• Provides for monthly payment in equal installments — the so-called subscription fee for the ordered capacity.

In the event of arrears, the GDM operator has the opportunity to apply a simple mechanism of influence — physical disconnection of the facility from the gas distribution system. This leads to the fact that the consumer is either forced to completely stop gas consumption or repay the debt in order to restore the service.

3.2. Contract for storage, withdrawal and injection of natural gas

• Is a standard contract concluded with a gas storage operator in accordance with the Gas Storage Code.
• Payment is made:

• on the terms of prepayment for the ordered capacity;
• within 5 days after the end of the billing gas month, the consumer is obliged to pay in full.

• In case of non-payment, the gas storage operator has the right:

• to refuse access to underground gas storage facilities;
• to prohibit the submission of trade notifications on the alienation/acquisition of gas volumes;
• to block withdrawal, injection or storage gas.

• If the customer has gas volumes remaining in storage, they are temporarily stored, but the operator has effective mechanisms to enforce payment.

3.3. Natural Gas Transportation Contract

• Concluded by customers of transportation services (suppliers, gas producers, wholesale buyers) with the gas transportation system operator (GTS).
• The contract covers:

• domestic gas transportation;
• until 01.01.2025 – also gas transit through the territory of Ukraine.

• Special feature: all payments are related to tariffs for entry and exit point capacity, which are established by the National Commission for the Regulation of Energy and Utilities of Ukraine.
• Payment is usually made on the termsah 100% subscription, and customers can book:

• annual capacity (the cheapest, but rarely used);
• quarterly;
• monthly;
• daily (the most expensive, with a coefficient of 1.1).

• An important aspect is the accuracy of consumption forecasting:

• if the actual selection exceeds the ordered volume, the supplier pays additionally with a coefficient of 2.

• This makes regular contact between consumers, suppliers and the GTS operator key to minimizing financial risks.

3.4. Financial aspects of the natural gas transportation contract

The main subject of the contract is money

• All relations between the customer and the GTS operator are reduced to financial settlements.
• Since 2016, the NEURC tariff methodology has been in effect, which is based on the capacity of entry and exit points.
• The customer pays depending on the selected entry/exit point.

Types of capacities and their features

• Annual – the cheapest, but practically not ordered.
• Quarterly – cheaper than monthly, but less flexible.
• Monthly – average in cost.
• Daily (“day in advance”) – the most expensive, with a coefficient 1.1.

Problem: It is difficult to predict gas consumption, so most suppliers book daily capacity.

100% prepayment and sanctions

• Payment is made in advance.
• If, according to the results of the month, consumption exceeds the ordered volume, coefficient 2 is applied.
• This stimulates accurate forecasting and constant contact with the GTS.

Communication “consumer – supplier – GTS”

• Daily reporting is critically important for minimizing costs.
• Problem: consumers can order a monthly volume, but use it in a few days due to the production cycle → additional costs for the supplier.

Ways to settle transportation costs

• Option 1: the supplier includes the transportation tariff in the gas price → one total figure for the consumer.
• Option 2: The contracts separately specify the price of gas and compensation for excess capacity → disciplines the consumer.

Capacity at entry points

• Ordered by importers and gas production companies.
• Payed to the GTS operator and, usually, included in the final gas price for suppliers.

Disputed payment – imbalances

• The GTS operator must ensure balance: as much gas entered the system, the same amount must leave.
• Transportation service customers receive data on their balance and are obliged to prevent imbalances.
• Payments for settling imbalances often become the most conflicting in the relations between the parties.

3.5. Financial guarantees in the gas transportation market

Bank guarantees (since 2015)

• Introduced as a tool to cover part of the suppliers’ obligations to the GTS operator.
• Problems at the beginning:

• • the bank that issued the guarantee could become insolvent at the moment when the GTS demanded payment;
  • the GTS operator was left with losses, since the gas had already been consumed.

• Consequence: abuses and loopholes, which were gradually eliminated.
• Today: suppliers provide security not only with guarantees, but and:

• • cash,
  • collateral,
  • surety agreements.

• As a rule, the amount of the collateral corresponds to the amount of the bank guarantee.

Direct financial security

• The GTS operator may require the transfer of funds to a special account depending on the volume of transportation.
• The customer transfers the required amount, and in the case of negative imbalances, the GTS operator uses these funds. This allows you to quickly cover losses and avoid the risks of non-payment.

New financial mechanisms. Escrow agreements (from 2023)

• Essence: the bank opens an escrow account.
• Funds are debited from the account only after certain conditions are met.
• The role of the bank: to guarantee a fair distribution of funds between the parties.
• Practice: actively used by Oschadbank and Ukrgasbank.
• GTS protection mechanism:

• • in the event of imbalances or debts, funds are automatically debited fromaccounts;
  • the GTS operator avoided the risk of losses and maintained the financial stability of the system.

Thus, financial guarantees in the gas market have evolved:
bank guarantee → direct collateral → escrow accounts,
which increases the level of protection of the GTS operator and disciplines market participants.

 

4. The issue of imbalances and the role of financial guarantees

The most sensitive issue is the settlement of imbalances

• The GTS operator bears the key responsibility for balancing the system.
• The settlement led to significant losses for the operator, because the gas was actually consumed, but the money for it did not arrive on time.

Reasons for problems with the settlements of GDM (distribution system) operators

• Objective – low tariffs that did not allow purchasing process gas at market prices.
• Subjective – reluctance to make timely settlements; use of gas and funds in their own business activities (“money today and money tomorrow are different money”).
• The benefit remained on the side of the GDM operators, while the losses fell on the GTS operator.

Financial guarantees on natural gas exchanges

• The exchanges establish their own trading rules and requirements for financial guarantees.
• Escrow accounts became the first protection tool:

• • participants open an escrow account;
  • funds are blocked until the terms of the agreement are fulfilled;
  • settlement between the parties becomes safe and transparent.

Perspective: clearing model

• European legislation provides central counterparty (clearing house), which assumes the function of a guarantor of the fulfillment of obligations.
• Clearing participants make mutual settlements through this central institution.
• This ensures the maximum level of financial security and eliminates the risks of non-fulfillment of agreements.

Situation in Ukraine

National legislation has recently been amended regarding organized commodity markets. However, full-fledged clearing, as in the EU, is not yet applied.

Currently, the main mechanism is escrow agreements, but they are considered a temporary solution.

Thus, the system of financial guarantees in the gas sector of Ukraine is still being formed:

• today the key instrument is escrow accounts,
• in the future – the transition to the European clearing model.

 

5. Conclusions

• Financial guarantees are a key instrument for the stability of the natural gas market.
• They protect suppliers, operators and consumers from the risks of non-payment.
• The use of prepayments, bank guarantees, escrow accounts and other mechanisms minimizes financial losses and increases market transparency.

 

Active links (NPA, standards, resources)

• Law of Ukraine “On the Natural Gas Market” (Vidomosti Verkhovnoi Rada (VVR), 2015, No. 27, Art. 234): https://zakon.rada.gov.ua/laws/show/329-19#Text
• Law of Ukraine “On the National Commission for State Regulation in the Energy and Utilities Sectors” (Vidomosti Verkhovnoi Rada (VVR), 2016, No. 51, Art. 833): https://zakon.rada.gov.ua/laws/show/1540-19#Text
• Gas Transportation System Code (GTS),approved by the resolution of the National Commission for the Regulation of the Energy and Utilities of Ukraine dated 30.09.2015 No. 2493:https://zakon.rada.gov.ua/laws/show/z1378-15#n18
• Gas Storage Facilities Code and Criteria According to Which the Contractual Access Regime or the Regulated Access Regime is Applied to a Certain Gas Storage Facility, approved by the resolution of the National Commission for the Regulation of the Energy and Utilities of Ukraine dated 30.09.2015 No. 2495:
  https://zakon.rada.gov.ua/laws/show/z1380-15#Text
• Gas Distribution Systems Code (GDS), Resolution of the National Commission for the Regulation of Energy and Utilities of Ukraine dated 09/30/2015 No. 2494: https://zakon.rada.gov.ua/laws/show/z1379-15#Text
• On Approval of the Form and Terms of a Bank Guarantee, Resolution of the National Bank of Ukraine dated 08/03/2021 No. 82: https://zakon.rada.gov.ua/laws/show/v0082500-21#Text
• Escrow agreement (conditional storage of funds) – Art. 1076¹ of the Civil Code of Ukraine: https://zakon.rada.gov.ua/laws/show/435-15#n5976
• Regulation (EU) No. 715/2009 pon conditions for access to natural gas transmission networks
  eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32009R0715
• Directive 2009/73/EC concerning common rules for the internal market in natural gas
  eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32009L0073